This post will be a short post as BioSyent is well known in the investment community and I have nothing material to add. Instead I will focus on how my view of a BioSyent type company has changed.

BioSyent almost perfectly embodies my maturity as investor. The company has grown rapidly, operates in a market that I am not well versed on, and is expensive.

In the past I would have overlooked BioSyent immediately. And to be honest I had initially overlooked it when it was first mentioned on twitter when shares where less than $1.00. As I was developing my qualitative skills as a microcap investor I wanted to get exposure to best in class management teams. A tagged along with a friend as was introduced to management of BioSyent. I was impressed and was willing to at the very least follow RX.v to see if there would ever be an opportunity to purchase shares at a more reasonable valuation.

I started formally tracking BioSyent in mid 2015. Shares were trading about where they are today after running all the way from under $1.00 to over $12.

I have seen a pattern with many high growth companies. The company usually is dramatically undervalued and shares trade extremely cheap. Then something changes the future of the business and the market is slow to react. The share price increases but not as quickly as the fundamentals of the business. As the company continues to execute the increase in valuation is higher than the increase in earnings. Suddenly, the company can do no wrong. Eventually the company’s momentum wanes and there is nothing to support the high valuation. Shares come back down to earth on the slightest stumble or pause in growth.

There are a few different likely outcomes:

The rise in earnings was a temporary phenomenon and the shares will continue to trade lower.

The rise is earnings is sustainable but the growth has disappeared as the share price needs to re-rate to the new reality.

The rise in earnings is temporarily paused and the company enters transition mode. New products/services are being introduced, but do not drive enough revenue to have an impact to overall results. While the transition period drags on the shareholder base is slowly churned through. Many start to question whether or not they will see growth again. Short term investors are slowly replaced by longer term investors who believe in the story.

Being long RX.v I obviously believe we are in the middle of the 3rd outcome. The valuation of RX.v is high, but I am comfortable that my capital is being put to work wisely and management is aligned with shareholders.

The share price may be volatile in the short term, but looking out 2-5 years, I beleive $8/share will appear cheap. BioSyent may have fallen victim to tax loss selling and/or additional selling pressure as a Canadian investor’s shun all things pharma related after the blowup of Valeant.

I mentioned on twitter way back in August that I was looking at O&G service companies again.

Thankfully I didn’t have to look far. My thought process for investing in oil and gas companies in the current environment is:

Must have the ability to cut expenses and run at or near break even (on a full year basis) at the current level of activity

Must have a clean balance sheet so the company can use the downturn as an opportunity to expand the business

The last thing I want is to have the company do a large dilutive share raise and multi-year lows in the share price

Must have a capable management team with high integrity and spacial awareness to understand where the current opportunities are

The idea is to find a company that can ride out the downturn and be a larger business providing more value for all stakeholders during the eventual recovery. If I am able to find a company that meets all three of these, then I should theoretically be hoping for a long pronounced downturn as it will only expose more opportunities for the business to grow.

Brief description of Pulse

Pulse Seismic Inc. is a Canada-based seismic data library company. The Company is engaged in the acquisition, marketing and licensing of two-dimensional (2D) and three-dimensional (3D) seismic data for the energy sector in Western Canada. The Company has a seismic data library in Canada, which includes approximately 28,600 net square kilometers of 3D seismic and 447,000 net kilometers of 2D seismic. The Company’s library covers the Western Canada Sedimentary Basin (WCSB). The Company’s seismic data is used by oil and natural gas exploration and development companies to identify portions of geological formations that may to hold hydrocarbons. The Company’s seismic data is used in conjunction with well logging data, well core comparisons, geological mapping and surface outcrops to create a map of the Earth’s subsurface at various depths. It designs, markets and operates participation surveys and grants licenses to the seismic data acquired to parties that participate in the surveys.

Let’s take a closer look at Pulse to see if it ticks all the boxes.

Ability to cut expenses to get to breakeven.

Given the nature of their product and the overall cost of the survey relative to the large expense of drilling for oil, they are able to maintain high margins regardless of activity. Their product is a very minor expense relative to the overall cost to drill. They are not interested in racing to the bottom in regards to pricing. That only damages their brand and will be very hard to claw back in the eventual upswing. Pulse has less than 20 employees and most costs for shooting the surveys are contracted out. As you can see below they have been able to maintain their margins with less business activity. The last chart shows that they have reduced opex to align with business activity. It’s reassuring that they are not sitting on their hands waiting for a recovery. They have also cut their dividend to preserve cash.

2. Clean balance sheet to leverage as opportunities arise.

The company has paid back all the debt it took on from a large acquisition in 2010 and is now in a net cash position. They have also purchased shares and used to pay a dividend.

Given the ability to mirror opex with business activity, this company could take on a decent amount of debt without concern.

3. High integrity management team with ability to see opportunities.

This part of the due diligence process is subjective. The qualitative part of an investment is always the trickiest. The board is completely independent, experienced in the industry, versed on capital markets, and together own over 30% of the company. They also give a skill matrix in their MIC.

Management compensation is reasonable for a company this size. Their competition is global, were as they are not. So they need to know the geography inside and out. As well, the sales team needs to know the ins and outs of every project in the territory.

They have a couple of levers in regards to business growth.

They can make a straight up purchase from E&Ps directly. The value of the contract may not be material to the overall costs associated with drilling for oil. Having said that, during a downturn all options are explored to be monetized.

They could buy surveys from a competitor. Though not likely, it is always possible.

They could conduct another participation survey. They help by doing some pre-funding but most initial costs are paid by end users.

Summing it all up

I think Pulse ticks all three boxes. In order to invest in this company you have to get comfortable to their exposure to oil and gas.

Pros

able to mirror expenses with activity quite easily

high value add product to customers

no debt

Cons

given how unique the business is, growth opportunities may not present themselves

they never really get expensive on a P/E or EV/EBITDA valuation

It’s likely from the fact that their revenues are not recurring and they have exposure to an industry which is extremely cyclical

Let me know if you are finding any value out there.

Thanks,

Dean

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I am going through my current portfolio and sharing thoughts on my holdings in hope of getting some feedback from readers. At the very least, it’s a therapeutic exercise for me. Please don’t expect clear succinct thoughts from these posts, it’s more of a mental dumping ground for my brain.

I originally wrote up Sangoma way back here and briefly mentioned it here. Since writing Sangoma has made some acquisitions (and integrated them), invested new products and services, and is seeking a larger share of wallet from customers. Since coming onboard, the CEO has stated that he wants to grow top line and move away from one time product sales towards having recurring revenue to remove lumpiness in the business.

All this has led to a shift in the financials as the new services, acquisitions, and legacy products all have different margin profiles. As with many analysts on the conference calls, I was somewhat skeptical of the desire for top line growth given how much cash was sitting idle. Most of the high cash net-nets sit on cash and do nothing with it. At least with Sangoma, management was acting.

All the hard work has led to a higher top line, less lumpiness through the year, and still have the combined gross margins above 60%. Operating margins have been challenged as this work was integrated and more expenses were required to market to new verticals and geographies. All this was done while maintaining positive net income over the last two years in a corner of the market that is not booming.

The tone from management has been consistent stable growth in top line will translate into a stronger bottom line eventually. Around 40% of revenue is now coming from services and the legacy products now make up about 30% of revenue.

Below is a look at their product vs. service revenue mix. Quite a change. And you can see the working capital required as a % of revenue has declined as well.

Over the last two years there have been some angry investors attending the conference calls that were not supportive of management’s actions (I could only imagine how many emails and calls the company has gotten directly). From my vantage point, management has executed the plan that they have consistently communincated to investors.

Will 2017 be the year that we see the hard work bear fruit? I am betting on it.

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I recently sold Paul Mueller Co. I thought I would go into a little detail on the decision. The decision relates to how I have evolved as an investor. For those who want the history, please read my previous post.

Paul Mueller Company is a provider of manufactured equipment and components for the food, dairy, beverage, transportation, chemical, pharmaceutical, and other industries, as well as the dairy farm market. Overall I think that the company has done a decent job running the business. Of the four segments (Dairy Farm Equipment, Industrial Equipment, Field Fabrication and Transportation); Dairy and Industrial make up the majority of the top line for the consolidated company.

Dairy has been stable since the acquisitions post 2007-08. I was hoping for the Industrial segment to post some sort of turnaround in 2015. That has not happened.

The company’s valuation is still quite cheap without any contribution from the Industrial (or Field Fab and Transportation) segments.

So there are a few questions to get comfortable with the company as an investment:

Does the Dairy segment continue to do well?

Does Industrial turn around?

If yes to the first two, does the valuation of the company improve?

And aside from all 3 of those, is this a business run by quality mgmt?

Lastly, does the pension liability on the balance truly reflect reality?

I honestly can’t really answer any of the above. I never really could. My original thinking was that if I buy shares cheap enough, I don’t really need to answer any of these questions. That’s not a bad way to invest, it’s just not the way I have gotten the most comfortable with.

When you buy a business like MUEL, you are buying a business with low(ish) product differentiation, capital intensive, and the business is subject to shocks that are beyond the control of the current management team. As well, you aren’t getting a ton of communication with the outside investor world. When buying microcaps, you hope for a business that is somewhat nimble, you aren’t getting that with MUEL.

It should be mentioned that MUEL has recently announced a share buyback. With such low volume on the stock, it could really move the stock higher.

In order to properly accommodate all the specific risks with MUEL you would need a portfolio that has 20-30 names. As well the amount of churn in the portfolio would have to be high. Something I don’t have time nor the personality for.

You may think that I will shun commoditized businesses or a business with little product differentiation to end users, that is not entirely correct. I have been putting a lot of thought into whether or not you buy companies that are part of a market that is commoditized or with little barriers to entry, and the answer of course….it depends. I’ll try and get some thoughts down to encourage conversation.

Thanks,

Dean

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I feel bad sometimes for not posting more on the Petty Cash. The site has brought a ton of connections and ideas to me and sometimes I forget that. I heard somewhere that the key to any successful relationship is low expectations, I think that applies to anyone still following the site. Expect (next to) nothing and be happy when anything happens.

I want to take some dedicated mental energy and share how the transition from owning a home to renting has been. To be fair, I don’t know if owning is better than renting I just know it works for me. This won’t be me convincing you to rent or buy, but just me putting some thoughts, feelings and experiences out there. For my family owning vs. renting really came down to the math.

I know there are many home owners out there who are waiting for a crash and want to time the market. As well, there are many people who don’t own currently that feel the societal pressure to own a home.

First, the former is just a stupid idea. To think you can actually time when the market is going to crash (and presumably jump back in after the crash) is asinine. Your ability to time the market is likely no better than anyone else’s.

The latter is tough to quantify. Generally we have been taught as Canadians that anyone successful owns a home and learn to associate renting as someone who “is starting out” or “doesn’t get it”. People said congrats when I told them that I was approved for a mortgage. In fact, many people brag on how much they are approved for. When I tell people that I sold my house to rent I get this puzzled look. Most immediate dismiss anything that comes out of my mouth after that. “How can he know anything about investing (or anything else for that matter) if he isn’t even smart enough to buy a house.” That’s what I imagine others are thinking of my decision. It takes more courage than you realize to act upon something that makes sense for your family when you know you will be scrutinized by your peers, friends, co-workers, etc.

For me and my family it came down to math. Simply removing emotion and letting actual facts make the decision.

Owning – pros and cons

Pros

capital appreciation in the house

one should note that unless you are able to pick the right house, capital appreciation expectations should be limited to annual inflation rate as housing costs make up a large portion of the annual inflation rate

likely inflation protection vs. holding cash in a bank account

stability (for the term) in mortgage payments

ability to pay off mortgage faster and get a guaranteed after tax way to build your net worth

Stability for the family – I can pretty much know where I will live for the foreseeable future

can borrow against the house (via HELOC) for anything I want

Tax free capital appreciation for your primary residence in Canada

It’s easier to fit in

Cons

Property tax goes up pretty much every year

Can be expensive

You buy a new(er) house and have big payments

Something to note is that many have had bad experiences with new homes still not being built with high quailty

Or you buy an older/fixer-upper and have to spend time/money maintaining it

Reduced mobility

it takes a lot of time and money to move (especially if you have a family)

Your Time required

cutting the lawn, painting, shovelling snow, raking leaves, etc

Renting – pros and cons

Pros

the biggest one for me is time

none of my time is dedicated to maintaining the house: no yard work, no snow shovelling, etc

usually you can lock in your expenses for a minimum of a year (likely longer)

no surprise breakdowns/repairs that you have to pay for

most people who rent have high mobility

they are able to pick yup and move quicker

that means less “things” which for me led to less mental clutter and more time/energy to focus on the things I truly value

If you have capital built in your house, you now have better access to it

Cons

You can have very little notice on when your house/condo/apartment can be sold and you have to move

You have to make rent payments as long as you rent

eventually when you own you stop making mortgage payments

I mean that’s the dream right?

You get to live in your house for free at some point

You could have a bad landlord

You aren’t able to “make it mine” by painting the rooms whatever color you want or knocking down a wall or renovating the kitchen

For us it was a matter of taking the capital that was tied up in the house and investing it in the public markets to (hopefully) get a higher return than if the capital was left in the house. This of course requires a ton of time.

You also have to consider ALL the expenses with home ownership. Property tax, utilities, sewer, additional fees from the city to upgrade streets, appliances, anything that breaks down.

Once we ran the numbers and realized that it makes sense for the family, we executed in pretty short order. It was actually quite therapeutic to downgrade the size of our living space. We got rid of a ton of things that we didn’t need. Without being forced to move, we likely would have kept many of those things.

Post Move Feels

Positive

The largest thing that I noticed since we moved was how much extra time I have to do things I really want to do. I have been surprised with how much I’m into fitness. I spend a decent amount of time in the gym and wouldn’t be able to do that without sacrificing something else if I had a house to maintain. I also get more family time which is really appreciated in Edmonton’s short summer. Investing performance has improved as I spend more time understanding each business I purchase.

Probably more important that the time is the reduction in mental clutter. I don’t worry about remembering to do or organize something related to the house.

Going against the grain by renting has given me courage to challenge other societal norms. If I didn’t try renting then I wouldn’t have the courage to challenge other traditional beliefs.

Negatives

We have less geographical security. Once in awhile you hear a horror story about someone renting and having to move with very short notice. This has crept into my thoughts a few times. We like to keep as nimble as possible so we are able to react to surprises.

Even after almost 2 years, I still have friends and family think that I’m “wrong”. It’s funny how many people have it ingrained that you just own a home.

Not sure if it’s positive or negative, but many people want me to look stupid. Since they are so emotionally attached to rising house prices, they feel that anyone who doesn’t own a home is a bet against their fundamental beliefs and values. It’s hardened me as a person. In my 20s I would seek acceptance from people, in my 30s I really don’t care what others think of me.

Concluding Thoughts

The only thing I would encourage the reader of this article to do is to ask yourself what is right for you. Not what is easy. But what makes the most sense for you as a person. It wasn’t always easy and yes there is always times of doubt, but in the end renting has been a worthwhile endeavour.

If anyone has a similar experience, please share it.

Thanks,

Dean

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Microcaps are not for the faint of heart. The same thing that can give a small investor like myself an edge also leads to volatility around earnings time. Many small and microcaps don’t do much to keep investors in the loop regarding business updates (especially when they are negative). They also lack institutional following to assist in the information dissemination process.

I was recently reminded of such volatility when MUEL reported earnings a few days ago. The share price responded by dropping nearly 30% on the day. Since the shares started the week pretty much where I originally purchased them, I am essentially down 30% on my position. I need to re-evaluate the position and make a decision to add, maintain or sell.

The original thesis was a function of a few different factors (those interested should check out OTC Adventures latest post on MUEL):

Continued deleverage of the balance sheet, including:

minimal impact from the company’s pension liabilities

pay down of debt (or at least not increasing leverage)

management of working capital

Execution of the largest reporting segments (Dairy and Industrial), including:

continued execution on the Dairy segment

progress on turning around of Industrial segment

overall margins on a consolidated basis

strong message from CEO on the other segments

Balance Sheet

Pension Liabilities

I am no expert on company pensions. Over the years I have strayed away from companies that have large pension liabilities. For the most part, they have a ticking time bomb feeling to them. But that is truly an unfair statement. There are companies that have defined benefit pensions that are not underfunded or at the very least are not dramatically underfunded enough to be a worry.

What I have decided is good enough for me in order to pursue an investment in the company is:

pension that is not enormous enough to distract the company’s management team from executing on growing the business. it should be mentioned that the size of the obligation can be crudely modelled into a fair value for the stock

MUEL seems to have this part under control in my mind. The size of the obligation is high, but there is little mention of it by the CEO in the letters to shareholders and (due to the next few points) I don’t think it consumes a ton of management attention.

Discount rates currently at 5.34% and expected return is 6.78%. Seems reasonable over the long term. It should be noted that both have been trending down over the last 6 years.

Investments in the plan are a mix of equities and fixed income. Equities include a broad range of publicly traded securities (including US listed and ADRs). Fixed income is made up of high quality corporate debt and government debt. Currently 61% of the plan is in equities and 38% in fixed income. It passes this test for me.

Lastly, there has been some initiatives put into place to reduce the total liability over the long term. There is a couple of moving pieces here, here’s the language from the latest 10-k.

You can see the initiative bearing fruit as the service cost under the benefit obligation summary has been zero for the last 3 years.

Overall, I am mindful of the pension liability, but feel the right measures are in place to simply include some form of the obligation into the valuation of MUEL.

Pay Down of Debt

Given the pension liability, I view this as important to minimize balance sheet leverage. In this instance management has been executing for the last number of years.

Working Capital Management

There have been stories of some businesses running into hard times simply because they don’t manage their working capital. Here I look at 2 metrics; CCC and working capital as % of TTM rev. To be fair, I haven’t smoothed these numbers out to take an average amount over the course of a year, so they are not perfect. But from my vantage point, they are enough to show that the company is not in a risky position with it’s working capital.

Overall I am happy with MUEL deleveraging the balance sheet. The main sore spot over the last year has been the pension obligation increasing on the liability side of the balance sheet.

Business Execution

The Diary and Industrial segments have been 80-90% of revenue for the past 6 years. So if you wanted to see what will move the needle, you need to understand the underlying mechanics of each and have confidence in execution.

Dairy Segment

A couple of acquisitions in 2008 changed the segment dramatically. Sales rose dramatically due to the acquisitions. Since 2008, sales have been between 70-90 mil with EBITDA slowly expanding to the 15 mil mark in 2014. This is the most valuable part of the business by far. Having said that, starting in 2015 there will no longer be a quota on mild production in Europe. This will impact the Diary business to a large degree. At this point, it seems to be a short term non-event with a medium term tailwind. You can read about it here. Something to monitor for sure.

Industrial Segment

The other large segment is the Industrial segment. Results have not been good over the last 10 years.

There is no surprise something labelled Industrial is cyclical. Part of the reason I invest in small companies is that expect them to be nimble to a certain degree. The other part is that I would the CEO to be able to make change to culture of the business in shorter order than a larger company.

Processing Equipment is the largest part of this segment. In 2013 the Processing Equipment portion earning 6.3 in pretax profit on better efficiencies and margins, meaning the remaining parts of the business lost around 8.1 mil. In 2014, the Industrial segment as a whole lost 0.652 mil and the Processing Equipment had a “small loss”. One can infer that the other Industrial portions of the segment were around breakeven. That’s quite an improvement. This is confirmed in the letter to shareholders with the statements being generally positive with the other parts of the Industrial segment.

I do have a concern with the Industrial segment on a consolidated basis. I would assume that some tough decisions are in order for this part of the business as the CEO has now been in place for 2 years and yet the Industrial segment is not performing.

Overall Margins

Gross margins are down in Q4 2014 from a year ago. As the chart shows, given the low gross margins inherent in the business, one needs to be really comfortable with the management team’s focus on doing business that makes sense financially and not “making work” to stay busy which is a struggle for many production related businesses with unionized labour.

CEO Message Around Business Culture and Shareholder Interests

The company doesn’t have quarterly conference calls, and doesn’t participate in investing conferences. However, the annual letter to shareholders does set a tone of accountability by naming the various manager of the various divisions. It also mentions revenue and margins to some degree, but does not give exact numbers for analysis purposes. Also, managers compensation is more closely tied to the business segments in which they are responsible for.

There is mention of efficiencies in processes and right sizing of headcount a few times. For this to be talked about openly is a positive and gives at least some confidence that the management team can make tough decisions if needed.

Other things of importance

The other 2 segments (field ops and transportation) are performing well except an accident at a customer site with a field fabricated unit where the company has taken a 2.9 mil reserve against the accident

MUEL used to pay a dividend, but stopped in 2009

Lower Euro hurts the Diary operations in Europe

Backlog is down from a year ago, but within is last 3 year range

David Moore has taken over as CEO in 2013, he has been with the company since the late 90s

Valuation

I think the best valuation metric for this type of potential investment is either EV/EBIT or EV/FCF.

Including the pension in the calculation is up for debate. Something should be included in my opinion. How much, I’m not sure. Given the way pensions are calculated leads to wild swings in value. This is why it makes no sense to use book value as a metric for this business. I think given the ROC potential (20%+), even just the crude measure of including the entire liability still makes this company cheap.

As far as upside goes, one could paint a picture with continued strength in Dairy and some modest profit from Industrial. Couple this together with some operating earnings from Field Ops and Transportation, I could get to 16 mil in operating earnings. This would put current shares at 4.14 EV/EBIT or 6.35 EV/EBIT if you include the pension obligation. If the business is earning those kinds of margins, I would think a valuation almost double today’s would be fair.

Caveats

There are some things I need to understand before making any sort of a move:

Increased context on the pension calculation and more information on the employees on the defined benefit plan. What does this look like on a go-forward basis

More information on the accident that caused the 2.9mil provision. Specifically, what is the company’s risk mitigation strategy when one accident can make up a reserve charge that equal to 20% of the segment’s revenue

What is going to be done with the Industrial segment and when can we expect some sort of stability in that business

Additional context on the milk quota removal and what it means to the dairy segment

Some color on the backlog

I plan on attempting to contact management over the next week or two to get this information over the phone.

Feel free to comment.

Dean

Disclosure:

The author is currently long MUEL, but that can change at any moment, so do your homework.

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This post will not involve in depth company analysis, instead I wanted to catalog some things that have changed with my philosophy when it comes to picking stocks to invest in. Recently, some good news was released on one of my top holdings that clearly displays my change.

I started purchasing Pivot Technology Solutions (PTG.v) in the summer of 2014. The idea behind the investment was a cheap company with decent ROIC (though admittedly low margin), capable management and a large overhang in the capital structure. There was a large amount of preferred shares outstanding that I felt were preventing the company from being properly valued by the market. The common shares are illiquid and well under $1, making it something that many institutions would ignore. Given who owned the common and preferred shares, it would make sense to do some sort of conversion of the preferred to common to clean up the capital structure. Management had mentioned several times that they had intended to do so.

I continued to purchase shares throughout the fall of 2014 as the company executed on operational promises to investors. There was still mention of some sort of conversion in the future. I was happy with management running the business and the focus on operations. I figured the conversion eventually happened whether organically or being forced by some sort of activist once the value of the business was made apparent.

At the beginning of March 2015, the company announced some good news:

company officially initiated a process to convert the preferred shares to common shares

announced a normal course issuer bid to repurchase. though many company’s announce this and don’t follow through

initiated a quarterly dividend starting in Q3 2015, annual yield at today’s price is around 10%

Old vs. New

The previous version of myself would have simply sold the shares on the good news and likely plowed the winnings into something that was “cheap” (likely one of my losers). I would put money into something the market doesn’t understand and likely a dinky little company that abuses the share price and struggles to execute. I would expand the numbers of company’s I own, which has two effects on the portfolio.

Another company for me to keep tabs on, therefore increasing the demand on my time to maintain an understanding of yet another business with yet another management team.

Increasing the number of company’s in the portfolio reduces the effect that the winners have on the portfolio as a whole.

The new version of me took a few days to reflect and reassess. I reviewed the business, the management team and what I see as the market’s expectation going forward. I have concluded that shares are still cheap, and I have recently increased my position.

Why would I sell a cheap company that is growing and shouldn’t need to dilute shareholders in the future?